Brain Drain or Brain Gain? Evidence from Corporate Boards

Mariassunta Giannetti is Professor of Economics at the Stockholm School of Economics. This post is based on an article by Professor Giannetti; Guanmin Liao, Associate Professor of Accounting at the School of Accountancy, Central University of Finance and Economics; and Xiaoyun Yu, Associate Professor of Finance at Indiana University, Bloomington.

Development economists have long warned about the costs for developing countries of the emigration of the best and brightest that decamp to universities and businesses in the developed world (Bhagwati, 1976). While this brain drain has attracted a considerable amount of economic research, more recently, arguments have been raised that the emigration of the brightest may actually benefit developing countries, because emigrants may eventually return with more knowledge and organizational skills. (See The Economist, May 26, 2011.) Thus, the brain drain may actually become a brain gain.

In our paper, Brain Drain or Brain Gain? Evidence from Corporate Boards, forthcoming in the Journal of Finance, we demonstrate a specific channel through which the brain gain arising from return migration to emerging markets may benefit the overall economy: the brain gain in the corporate boards of publicly listed companies. Specifically, we highlight the effects of individuals with foreign experience joining the boards of directors on firms’ performance and corporate policies in China.

The arrival of individuals with foreign experience in the board of listed companies in emerging markets can enhance the firms’ productivity and performance, because board members perform an important advisory role for the management (Fama and Jensen, 1983). Board members with foreign experience, having learnt how foreign organizations work, may facilitate the adoption of superior management practices, which—as shown by Bloom and Van Reenen (2007)—greatly enhance the performance and productivity of firms. Board directors with foreign experience could thus help bridge the large productivity gaps that persist across countries and firms (Hall and Jones, 1999; Jones and Romer, 2009).

Directors with foreign experience may also perform more effectively the monitoring function of the board and help improve firm level corporate governance in emerging markets, not only thanks to the foreign expertise accumulated abroad, but also because, being relatively disenfranchised from local ties, they may have stronger incentives to pursue profitability rather than pleasing politicians and other local constituencies.

We explore whether directors with foreign experience lead to performance improvements using a unique dataset from China and by exploiting exogenous variation in the supply of directors with foreign experience caused by policy changes. We hand-collect information on foreign education, work experience and other demographic characteristics from the bios of 32,823 executive and non-executive directors of 1,667 publicly listed companies from 1999 to 2009. We consider an individual to have foreign experience if he or she studied and/or worked outside (mainland) China.

China is an ideal environment to address this issue for the following reasons. First, Chinese firms face talent shortages in filling managerial positions. Since individuals with foreign experience are scarce, not all firms with similarly high demand for directors with foreign experience are able to attract one. Second and most importantly, during the sample period, almost all provinces, at different times, introduced incentives for highly skilled individuals with foreign experience to return. Since the labor market for board directors is largely local (Knyazeva, Knyazeva and Masulis, 2011), the introduction of the provincial policies determined exogenous changes in the supply of potential directors with foreign experience.

We find that when individuals with foreign experience join the board of a company, the firm’s valuation improves and its total factor productivity increases. Furthermore, in the subsequent years, the firm’s profitability increases. We also show that these improvements in performance are accompanied by changes in corporate policies that are generally set by the board. First, firms’ propensity to manage earnings decreases and CEO turnover following low profits increases, indicating that corporate governance improves. Second, among the firms that make mergers and acquisitions, the ones with board members with foreign experience are more likely to make an international merger or acquisition. This suggests that these firms are able to access a broader range of investment opportunities. Similarly, firms with board members with foreign experience are able to access more sources of external financing, as they are more likely to engage a foreign investor when raising capital through private placements than other firms without directors with foreign experience. Lastly, firms that hire directors with foreign experience start exporting more. Overall, these results suggest that firm performance improves because, among other effects, directors with foreign experience facilitate the adoption of strong corporate governance practices and internationalization.

The full paper is available for download here.

 

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